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Phone Tax Suit Revived

A
panel of the U.S. Court of Appeals for the District of Columbia
ruled that taxpayers could challenge under the Administrative
Procedure Act (APA) the IRS’ method of refunding long-distance
telephone excise taxes.

The
2-1
decision in Neiland Cohen v. U.S. (docket no.
08-5088) reversed and remanded a dismissal of the case by the
District Court for the District of Columbia. The appellate court’s
opinion by Judge Janice Rogers Brown issued Friday sharply
criticized the IRS’ position as “mean,” demonstrating “chutzpah” and
demanding “clairvoyance” of taxpayers. The case had been
consolidated with two others.

The
3% excise tax on phone service under IRC § 4251 had been challenged
by a number of taxpayers with respect to toll calls. IRC § 4252(b)
defines taxable service as including long-distance calls for which
the charge varies with time and distance or is billed by a flat fee
for calls within a specified nonlocal area. However, taxpayers
argued, because of changes in telecommunications, distance-related
charges no longer applied in most cases. After several circuit
courts had ruled against the IRS, the Service in Notice 2006-50
announced it would stop collecting the tax on charges based solely
on transmission time and provided a procedure for refunds. Taxpayers
could claim refunds on their 2006 income tax returns for either
actual taxes paid from 2003 to 2006 or a safe harbor amount (for
individual taxpayers, between $30 and $60, depending on number of exemptions).

The
district court ruled that Cohen had not met the requirements of
section 7422, which generally bars any refund suit until an
administrative claim has been filed. On appeal, Cohen argued that
the refund scheme violated the APA, which is codified under Title 5
of the U.S. Code starting at section 500. Notice 2006-50 could be
reviewed under the APA because it was a final agency action
resulting from IRS deliberations and altered the legal rights or
obligations of the Service, tax collectors and taxpayers, the court
said. As such, it constituted more than a mere statement of policy
under which the IRS exercised discretion, as the Service had argued
at trial, particularly since it amounted to an admission that the
taxes had been illegally collected, the court said.

As
for the Service’s argument that taxpayers were not required to
follow the notice to file suit, “that’s just mean,” Brown wrote,
citing a “virtual house of mirrors” of contradictory form
instructions. Likewise, she wrote, filing an informal claim to
satisfy the statutory requirement, as the district court had
suggested, would likely have ended in frustration.

“Despite
the obvious infirmities of these options, the IRS still has the
chutzpah to chide taxpayers for failing to intuit that neither the
agency’s express instructions nor the warning on its forms should be
taken seriously. … Taxpayers bear a heavy burden when pursuing
refund claims, but we have yet to demand clairvoyance,” she wrote.

In a
dissenting opinion, Judge Brett M. Kavanaugh
acknowledged the plaintiffs’ complaints that they were
undercompensated by the refund scheme. However, they did not
properly seek refunds within that scheme or the administrative
exhaustion requirements of sections 7422(a) and other provisions
rejected by the majority that have been repeatedly upheld by the
courts, he said.

“The
question here concerns only the timing of judicial
review, not the availability of judicial review,”
Kavanaugh wrote.

The results of the 2016 presidential election are likely to have a big impact on federal tax policy in the coming years. Eddie Adkins, CPA, a partner in the Washington National Tax Office at Grant Thornton, discusses what parts of the ACA might survive the repeal of most of the law.